The Myth of China Dumping US Dollars (FREEPOM)

Economics, FREEPOM15 Comments

Why America Has a Strong Position in the New Bretton Woods Negotiations

By JC Collins

This article was originally posted on December 29, 2015.

Understanding how balance of payments work is key to understanding the monetary leverage which one country holds over another.  Based on the modern method of money creation, the functionality of balance of payments is really a zero sum game.

Allow me to explain.

The importance of aligning all nations within the same structural central banking framework becomes obvious when the fiat method of money creation is considered. The intent of this post is not to debate the merits and faults of such a system (eg. Fiat money creation allowed for the expansion of the money supply which funded the industrial revolution, but also indebted nations to each other, and in turn, to an invisible web of international banking interests), but to demonstrate the ebb and flow of wealth as it shifts around the world.

As we know here on POM, wealth is defined as the accumulation of human time and labor.

This is why human time and labor is consolidated under ideologies (eg. Socialism, democracy, communism, etc.), which are framed with borders around cultures, religions, and historical significance.  Time and labor are consolidated as a measure of GDP.  World GDP can be considered the total accumulation of human time and labor.

More accurately, world GDP can be considered the measurement by which human time and labor is used to manage the debt which is a product of the money creation process.  This money creation process is practiced by all nations.  As such, the movement of human capital, or resources, being time and labor, is allocated across borders through multiculturalism.  This can also be considered as a form of socioeconomic agriculturalism, or reallocation of human resources.  Much like a farming technique.

But I digress from the original intent of the article.  It happens.

When all GDP is consolidated, we find that the ability to manage debt is allocated by shifting wealth from region to region, or country to country.  The balance of payments is the method of measuring the complexity of the debts of nations.

Let’s explore further.

Every so often we hear that China will dump its holdings of US government debt.  But what isn’t explained is that the People’s Bank of China had to borrow renminbi (sort of, remember all money is created through the issuance of debt) in order to buy that American debt.  This statement alone will bring the article into clear focus for many readers.

Before moving on further let’s consider that there is only finite amount of wealth/debt/human time and labor (let’s call it GWM, Gross Wealth Management) in the world.  The allocation of this GWM is determined by a methodology which we will explore in further detail in another post.  For now we will focus on the balance of payments as the means to measure the GWM ability of countries and the existing international monetary framework.

As such, a deficit in one country will mean a surplus in another.  Balancing the deficits and surpluses between nations is the goal of a multilateral monetary framework.  And considering the debt method of money creation, holding a large surplus is just as detrimental as holding a large trade deficit.

The US government, which has used their domestic dollar as the international reserve asset, was forced to expand dollar denominated debt to meet the demands of the international GWM.  The interesting part of this formula is that other governments and central banks had to print an equal amount of domestic currency in order to purchase that US government debt.

Based on exchange rates, the People’s Bank of China had to create as many renminbi as dollars.  What this means is that the large surplus and USD denominated reserves which China currently holds cannot be considered wealth which is free and clear of debt. China had to borrow renminbi in order to purchase dollars.

When this reality is considered, we can make the determination that China’s large reserves would be useless when used as a financial weapon against America.  Any analysis which is based on such a strategy by China can be considered inaccurate and not considerate of the actual functioning of the international monetary system.

If China so-called dumped their large holdings of US government debt, it would cause massive inflation within the domestic Chinese economy.  How so?  Considering that China used RMB debt to purchase USD debt, once the RMB denominated funds are pulled out of US government debt, these renminbi would flood back into China and cause inflation.  Not to mention that this would hammer the Chinese exporting sector, which is something the Chinese authorities are keen to avoid as they manage the transition from a trade exporting economy to a trade services economy.

Not to mention that China dumping US government debt would only serve to reposition the US deficit by shifting capital flows elsewhere.  Increasing and reducing bond yields would work in tandem with exchange rate adjustments to shift this debt around, like cards in a shuffle game.  Chinese capital flows would shift elsewhere, say the EU, which would than see its own capital flows to the US increase.  It’s only the shifting of the balance of payments.  Nothing more.

The reduction and elimination of reserves altogether is where the international monetary system is moving in the future.

Carrying on.

China can use these large reserves to protect itself from a currency crisis.  The PBoC could sell dollars to support the renminbi, which is something they did several times throughout 2015.  This was completely misunderstood by most, with many headlines, both mainstream and alternative, fanning the flames of false dollar dumping.

China can also use the reserves to protect itself from an external debt crisis.  This is the probable use of the large surplus, as a process of sovereign debt restructuring will begin in the coming months.  The substitution of these reserves within an IMF reserve diversification, or reduction, strategy will benefit China the most.

These reserves also cannot be used by China to address a domestic financial crisis.  For many of the same reasons.

Exchange rate manipulation is one of the only independent means which nations have to influence the ebb and flow of GWM.  It is feasible to imagine exchange rates as the King Rat of international monetary functionality.  This is a strong insinuation of the framework which is used by the international banking interests.

Let’s break this down into more detail.

The PBoC continues to keep the renminbi weak against the dollar for the purpose of purchasing US dollars which are accumulated by Chinese business and exporters.  The People’s Bank of China borrows renminbi in order to purchase these dollars.

Once purchased, the PBoC cannot sell renminbi as it would be inflationary. Same as the US with dollars.  In order to prevent excess inflation, the PBoC issues new debt and raises the required reserve ratio of capital held by Chinese banks.  This has led to the increase of domestic debt within China.

The effect of all this is that the PBoC owes renminbi which it sold at low valuations, based on the exchange rate, and owns dollars at high valuations, based on the same exchange rate.

This is why a substitution and reduction in reserve accumulation is required.  Unless the world completely moves away from the fiat method of money creation, which is something I do not predict happening, the monetary framework will need to be restructured for the purpose of eliminating reserve accumulation and seeking an equilibrium in the balance of payments through some form of multilateral reserve asset.  - JC

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15 Comments on “The Myth of China Dumping US Dollars (FREEPOM)”

  1. JC,
    What though if China purchases gold in the form of US dollars to act as a universal reserve. In terms of value, they are able to lower US fiat currency and at the same time strengthen their position in terms of a proxy backed currency of the Renmimbi? They would be zero sum in terms of Yuan/Dollar and still flood the market with dollars to the point of hyperinflation of the dollar? The world in turn sees China in a position of strength while nearing breaking the buck.

    1. China and the US, along with all other nations and institutions are aligned on rebalancing the international monetary system. This entails moving towards a multi-currency framework based on the dollar, renminbi, and euro. All measures and strategies are working towards that common goal. The accumulation of gold by trade surplus countries, such as China, has always been the case. Outside of wild speculation surrounding gold and the intent of China, nothing would suggest that Beijing is going to implement a strategy which would see the dollar hyper-inflate. It's a constant struggle here on POM to separate fact from fiction. Most conclusions out there on gold and China do not take into consideration the published policies and mandates of the central banks and international monetary institutions. Anyone suggesting that China is attempting to remove the dollar, or replace the dollar as the sole reserve currency, simply does not understand this dynamic and path forward. No nation wants the responsibility of having the sole reserve currency, which is why a multi-currency system is being developed.

      1. Greeting JC;

        Speculation has it that in the up coming Shanghai G20 meeting there could be an agreement similar to the Plaza Accord from 1987 where currencies are devalued...

        From ZEOHEDGE:

        Why According To One Bank, Massive Central Bank Intervention Is Imminent

        Any time the relative performance of global financials to US Treasuries has stumbled as far as it has, as shown in the chart below, it has meant one thing - a major central bank intervention was imminent.

        At least that's the interpretation of BofA's Michael Hartnett, who shows that in order to provide the kick for the bounce in this all too important "deflationary leading indicator", central banks engaged in major unorthodox easing episodes, whether QE1-3, or the ECB's QE.

        Why intervene now? Here are the problems according to Hartnett:

        Problem 1: US economy in “bad Goldilocks”, i.e. US economy not hot/strong enough to lift global GDP & EPS; but not cold/bad enough to induce global coordinated response
        Problem 2: global policy-maker rhetoric in recent days shows “coordinated innocence” not stimulus, all blaming global economy for weak domestic economies (“Overseas factors are to blame”…Japan PM Abe; "drag on U.S. economy from greater-than-expected-slowdown in China & other EM economies“…FOMC minutes; “increasing concerns about the prospects for the global economy”…ECB Draghi; “the change in China’s growth rate can be attributed in part to weak performance of the global economy”…PBoC)
        Problem 2 is static, meant for media propaganda and jawboning; it can easily be removed once the global economy takes the next leg lower. Which incidentally would also resolve the gating factor of Problem 1 - as we have said for months, the Fed and its central bank peers need the political cover to launch more stimulus.

        And in a reflexive world, where the "economy is the market", this means just one thing - a big leg lower in stocks is the necessary and sufficient condition to once again push stocks higher, as policy failure is internalized, and global risk reprises from square 1.

        This is Bank of America's summary, warning that unless a major policy intervention is enacted, the market will then sell off to the next support level, below the 1,812 which has proven so stable since August.

        Stabilization of “4C’s” (China, Commodities, Credit, Consumer) allowed SPX 1800 to hold/bounce to 1950-2000; weak policy stimulus in coming weeks could end rally/risk fresh declines to induce growth-boosting policy accord.
        Here is a summary of the near-term events which stocks are betting on do not disappoint: G20 Shanghai (February 26-27); ECB (March 10), BoJ (March 15) & FOMC (March 16).

        And as documented previously, the one main near-term event Hartnett is focusing on is the Shanghai meeting next weekend. Recall:

        We remain sellers into strength in coming weeks/months of risk assets at least until a coordinated and aggressive global policy response (e.g. Shanghai Accord) begins to reverse the deterioration in global profit expectations (currently heading sharply south – Chart 1) and credit conditions.
        In other words, Hartnett expects a "Shanghai Accord" to be unveiled next weekend, one where like the Plaza Accord three decades earlier, the Yuan will be massively depreciated, which ironically would halt all piecemeal Yuan devaluation on expectation of future devaluation (as it will have already happened), and reset global monetary policy stability if only for a few more months.

        Said otherwise, if next weekend the G-20 disappoints and unveils nothing, the next big leg down in the selloff will have arrived.

        How likely is such a major intervention? Keep an eye on the recently surging price of Bitcoin for the answer, and also Vancouver real estate, of course.

        Take Care


    1. The PBoC works under the same principle as other central banks, such as the Federal Reserve. It is forced to issue domestic currency in order to buy the large inflow of US dollars which make up its large trade surplus imbalance. In essence the PBoC is the lender, same as the Fed. The difference with the Fed is that they issue the international reserve currency and export it to other central banks on reserve. This forces other central banks to issue domestic currency in order to purchase those dollars. It's what I have always meant by saying that the US has exported its inflation. Does that help?

  2. What is the difference between wealth and debt? If wealth is defined as human time and labor then is debt ownership or sort of like a demand on wealth. I am also not understanding how a surplus could be as bad as a deficit. Is money debt? What's the advantages of having a debt based money creation process?

    Is then owning debt the power to direct wealth? In that sense is having a surplus or deficit the same thing?

    1. Curtis, you are correct about debt being a demand on wealth, or human time and labor. The "benefit" of the debt based system is for the purpose of funding growth. The industrial revolution only began after the first central banks moved towards the fiat based system. Before that time wealth was accumulated and hoarded by a minority, as today, but there was little liquidity left to fund growth through innovation and development. The debt based system has provided us the modern world, but everything comes with a cost. We need to find something better in future years.

      China's surplus of US dollars were purchased by the PBoC issuing domestic currency. All money is created through the issuance of debt. This has put huge credit pressures on the national economy of China. They used this expansion of domestic credit to fund the massive growth over the last 10 to 15 years. The unwinding of this credit market, being in essence USD created liquidity, is what is causing problems in China today. By exporting so much and using dollars on reserve to balance those trades, the domestic currency supply had to expand in a proportion consummate with the exchange rate between the USD and RMB. A surplus position is better than a deficit position, but the money used to balance those trades has to be created through the issuance of debt. When the currency of one country is used on reserve to balance these trades the imbalances become systemic. Does this make more sense?

  3. So theoretically issuance of debt is the sovereignty as having a demand on human time and labor. Hence there are many sovereign nations all having different demands on finite wealth. The purpose of the issuance of debt besides control on the flow of wealth is to increase it.

    Reserve accumulation reflects a lack of capability to direct wealth by issuance of debt, is this correct?

    I now understand what you mean when you say that the system of debt issuance isn't gonna go anywhere any time soon

    1. Greetings Grumps;

      Here's an excerpt of his lengthy interview in which he calls for a 50% devaluation of the Chinese Renminbi "" OR"" total collapse of their system..

      "I think the most likely outcome, in the next recession one of the big uglies comes out.

      I don't know which one it's going it be - it's a race between China and a 50% deval versus a total collapse internally of their economy because of their credit bubble; whether it's Japan which we have all been waiting for and it hasn't happened but maybe it happens; or maybe it's the European banking sector forcing the hand of everybody else, and suddenly all the collateral in the system is worthless again because the European government bonds are worthless again; whether it's just the loss of central bank control over the monetary system; whether it's the dollar wildly overshooting and then maybe some debt jubilee and debt forgiveness that needs to happen.

      There's a whole host of things, it's almost impossible to know which one it is but what we need to care about is not trying to spot the one it's about is there going to be a domino effect."
      The way he's calling it; Heads you lose, Tails you lose...
      Because the game we're playing is actually Dominos
      Take Care


      1. Here's an interesting story:

        "Xiamen Municipal Government and the Shanghai Gold Exchange in Shanghai recently signed a memorandum of cooperation. Xiamen Mayor Bae Jin Jia, deputy general manager of Shanghai Gold Exchange Song Yuqin on behalf of the two sides signed a memorandum of understanding.
        Standing Committee of Fujian Provincial Committee, Party Secretary Wang Meng Hui Xiamen at the signing ceremony that history is an important node in the Xiamen Maritime Silk Road, has in recent years Taiwan has approved a comprehensive reform pilot area and China (Fujian) test area three free trade one of a Area. Shanghai Gold Exchange is putting the "all the way along the" gold strategy, Xiamen is committed to creating a 21st Century Maritime Silk Road and Taiwan exchanges and cooperation between the two strategic fulcrum city. The two sides will promote cooperation in various financial elements gathered in Xiamen, promote cross-strait cooperation in the depth of the gold market, gold market to enhance the China Maritime Silk Road countries and regions, and influence of radiation.
        Shanghai Gold Exchange Chairman Jiao Jinpu said in his speech, and Xiamen signed a memorandum of cooperation is a solid implementation of the national "along the way" strategy, an important measure for China to further promote the gold market opening. Exchange will work together with Xiamen, Xiamen accelerate the development of the regional gold market, gold market continues to explore cooperation across the Taiwan Strait, cross-strait financial cooperation and help deepen financial reform and innovation, Xiamen together to create "Chinese gold" Maritime Silk Road radiation belts were to build China's southeast coastal areas and cross-strait "golden future."
        The parties specifically, while adhering to the principle of financial services on the basis of the real economy, will play their own characteristics and advantages, carry out related business cooperation, particularly cooperation matters include: qualified investor groups work together to foster and support the steady development of the regional gold market; encourage and support both sides in Xiamen aspects of the gold market pilot business cooperation and jointly promote cross-strait gold market depth cooperation; support for the establishment of the Xiamen gold market development funds, to promote the maritime Silk Road gold industry to upgrade and build a comprehensive gold chain; supports the establishment of a free trade area in Xiamen gold bonded warehouses and gold refining plants, and promote the construction of Xiamen maritime Silk Road has become an important re-export center for gold and gold refining processing center."

        Looks like they're prepping for a regional currency bloc in which gold will play an integral part.

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